Types of Stocks You Should Avoid at All Costs
There are certain types of stocks that are risky by nature. It is either because they are more difficult or volatile to trade than the usual or they are just insufficiently regulated. And then there are also stocks that, despite being good investments, should be avoided during specific times, such as when their prices indicate a market bubble or because they are over-represented in a particular portfolio.
The following are some types of stocks that you might want to stay away from as much as possible.
Low Volume Stocks
Stocks that have very low average trading volumes per day are innately volatile. Trades worth several thousands of dollars in a particular day can cause a significant rise or fall in the price of low volume stocks. This is also means that it is possible to manipulate a price with no major investments. It is also difficult to sell and buy low volume stocks.
Every time you purchase a stock through any of the world’s major exchanges like the NYSE and the Nasdaq, you get to enjoy being protected by an extensively regulated market under the United States Securities and Exchange Commission’s jurisdiction.
Any stock sold outside the major exchanges, sometimes referred to as penny stocks, is mostly unregulated. Reports of their earnings might either be accurate or fraudulent. Retail investors who purchase them won’t be able to tell the difference. Sellers of penny stocks often participate in conspiracies to deceive investors. A good example of these is the so-called pump and dump scheme wherein a small insider group artificially inflates a certain stock’s value and quickly sells out to cause a plummet of the stock price and leave the rest of the investors with significant losses.
If the stocks in a certain sector do well in an unusual way, you might give in to the temptation to buy more of those stocks or other similar stocks within the same sector. This is not a good idea at all. The mere fact that a specific group of stocks does strangely well indicates that your assets are starting to concentrate too much in one sector that might leave you more exposed to unwanted risks. Instead of getting more of the best performers, you might want to sell them once they go beyond 5% to 15% of your investment portfolio. The number one requirement to survive in the stock market is and will always be diversification.
One good case of a bubble is the unprecedented rise in the prices of residential properties in the US from 1998 to 2006. Bubbles are usually ignored with investors always buying into them. Among the primary reason for this bubble is the phenomenon known as irrational exuberance. If an asset’s value increases dramatically more than its historical growth rate within a short timeframe, this is an indication of a bubble. Another one is if the ratio of price to earnings in a specific sector rises more than the historical price to earnings in that sector.
Steer clear of these types of stocks to prevent regrets and disappointments down the road.